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Inflation: ‘The real question’ is the cost of addressing it, strategist says

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MetLife Investment Management Chief Market Strategist Drew Matus joins Yahoo Finance Live to discuss inflation, yield curves, market performance, and the outlook for the Fed ahead of the upcoming FOMC meeting.

Video Transcript

RACHELLE AKUFFO: For more on the markets, let's bring in our guest, Drew Matus, MetLife Investment Management chief market strategist. So as we're seeing, Drew, a lot of red across the board here. Is this just a collective breath being pulled ahead of the Fed's action right now?

DREW MATUS: Well, I think, certainly, the inflation numbers on Friday really got people nervous and showed a lot of inflation in places where a lot of strategists were actually expecting inflation to roll over. And so that then raised the question of, how much more can the Fed do? How much more aggressive do they need to be? And maybe in the back of people's minds, is anything the Fed going to do going to be sufficient to restrain inflation, given the fact that a lot of it is supply chain driven or coming out of energy and food?

SEANA SMITH: Well, Drew, right now, out on the Street, there have been some calls for a 75 basis point hike on Wednesday. We know that Fed Chair Jay Powell actually took that off the table at the last meeting. Should that be something that the Fed needs to consider now?

DREW MATUS: I don't think so. I think they've laid out a framework. And I think they just need to kind of follow and execute on it. If you look at measures of inflation that exclude the near term, so-called five year or five-year forward inflation measures which show inflation 6 to 10 years from where we are today, those indicators of inflation are actually quite restrained.

So the market still has a lot of faith that the Fed is going to handle the inflation story. The real question, though, is, right now, is, what's going to be the cost of handling the inflation story? And I think more and more people are beginning to realize that it might come with significant economic cost.

DAVE BRIGGS: Are we talking recession, or do you think it's this year?

DREW MATUS: It's a little too late to be this year, quite frankly. I mean, things move pretty slowly, but if I had to put money on it, I'd think about a recession sometime later next year. Allow margins to continue to erode over the course of this year. Eventually, firms will cut back on hiring, and consumers will pull back more aggressively. And I think that's pretty much the now consensus among economists and strategists on the Street. And I think it's probably one of the few times where the consensus is probably going to be right.

RACHELLE AKUFFO: I want to ask you about buying the dip. Obviously, a lot of retail investors bought what they thought was the dip, and then, obviously, the markets continuing to tank, though. And BlackRock's chief global strategist gave three reasons why not to buy the dip-- increasing downside risks for profit margins, equities aren't much cheaper, and growing risk that the Fed tightens too much. Would you agree with that? Is this not the time? Is buying the dip not the mentality to have right now?

DREW MATUS: You know, so I mean, my job allows me to avoid having to opine on things like that. But what I would say is this. There's still a lot of uncertainty out there. And I think some of the market move and responses we're seeing are just the volume of things that you are uncertain about. Every investor out there, whether it's a professional or kind of someone sitting at home, has a limited amount of bandwidth that they can deal with.

And you can handle maybe inflation and interest rates, but then you have to throw in a growth story and geopolitical risks and a lot of other factors. And when it becomes too much, the natural response for people is just to pull back and simplify the decision making process. And usually, that simplification means people either decide to be risk-on, which they're clearly not, or they decide to be risk-off, which seems to be the way people are playing the volume of things that they're trying to handle right now.

SEANA SMITH: But Drew, when there's so much uncertainty out there, we need to point out what's going on in the bond market today because you have the 10-year yield hitting the highest level that we've seen since 2011, taking a look at the two-year rate, jumping to levels we haven't seen since before the 2008 crisis. Just focusing specifically on the bond market, what is that signaling?

DREW MATUS: Well, remember, I said that longer term inflation expectations are contained, right? And so a lot of the movement we're seeing in the 10-year sector is simply the result of twos and kind of shorter in sectors that are actually experiencing some inflation pressure. And so it's kind of funny. We always talk about the yield curve being an indicator of recession risk. But in this case, the fact that the yield curve is flattening is a sign that the markets believe that the Fed is not going to allow inflation to remain high forever.

And so it's holding down the longer end of the yield curve, the 10-year space, while the way they're going to do it, i.e. hiking interest rates, is pushing up the front end of the curve. And so it's one of those things where you can't just look at something and take it at face value. You have to understand exactly why it's happening and what that might mean. And I would say the flattening of the yield curve we're seeing right now is not an indicator of recession, but rather of faith in the Fed. And so if the Fed were to lose faith or people were to lose faith in the Fed, you'd see the 10-year yield moving up much more dramatically because of the inflation risk there.

DAVE BRIGGS: A lot of data out there, Drew, but the one that seemed to not get enough attention came Friday. And obviously, that was not the inflation number, but the University of Michigan's Consumer Sentiment Index, an all-time low, 50.2. Conversely, if the bond market is telling you faith in the Fed, what does that number tell you about what's coming the next couple of months?

DREW MATUS: Well, I think it's telling you that consumers aren't really happy with how things are developing. It's one thing to have a very low unemployment rate, easy time finding work. It's another to see kind of your savings being eroded by very high levels of inflation, and then of course, the risks that the Fed's going to keep hiking interest rates and maybe cause a recession.

And so, you know, consumers are looking at that and saying, you know, I'm actually worse off. I've got a good raise, but I go to take my family out to dinner. And if we order the same things, I'm 30% above where I was previously in terms of cost. And that means I can afford fewer things for my family. And so, instead of thinking about it as inflation, just think about it in terms of, is my life getting better or worse? And high inflation means your life is getting worse. And that's being reflected in the consumer sentiment data.

RACHELLE AKUFFO: Indeed. Well, a big thank you to our guest there, Drew Matus, MetLife Investment Management chief market strategist. Thank you so much.